Understanding severance pay

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. www.econstor.eu Terms of use: Documents in D I S C U S S I O N P A P E R S E R I E S ABSTRACTUnderstanding Severance Pay * Severance pay, a fixed-sum payment to workers at job separation, has been the focus of intense policy concern for the last several decades, but much of this concern is unearned. The design of the ideal separation package is outlined and severance pay emerges as a natural component of job displacement insurance packages, serving both as scheduled reemployment wage insurance and, if search moral hazard is a problem, as scheduled UI. Like any firm-financed separation expenditure, severance pay can induce excessive job retention, but such distortions do not appear to be of practical significance at benefit levels typically mandated in the industrialized world. Moreover there is no evidence that firms attempt to avoid these firing cost distortions by substituting severance savings plans, which have zero firing costs. Indeed severance insurance plans similar to those mandated are often offered voluntarily in the U.S. The appropriate role of government in the market for severance pay is briefly considered.

Job displacement risk and severance pay

“…This result may provide a rationale for the stylized fact that both privately negotiated and mandated severance pay is indeed increasing in tenure in most countries (Parsons 2013). …”

“…1 Many countries also mandate minimum levels of severance pay and other forms of employment protection. Both privately-contracted and legislated severance pay provisions are commonly increasing, approximately linear, functions of job tenure (see, e.g., OECD 2013 andParsons 2013). The existence of these measures is difficult to understand in the context of standard, complete-markets models in which workers maximize expected labor income and wages are perfectly flexible.…”

“…31 This average welfare criterion is used, for example, in Chatterjee et al (2007) and is comparable to the one employed by Alvarez and Veracierto (2001). 32 In most countries, levels of both privately-negotiated and mandated severance pay increase linearly with job tenure, subject possibly to a maximum limit (see, e.g., OECD, 2013;Parsons, 2013). Table A.9 in the Appendix reports levels of statutory severance pay for three different levels of tenure for a number of OECD countries.…”

“…1 Parsons (2013) reports that 36 percent of US workers in firms with more than 100 employees and 16 percent in smaller businesses, were covered by severance-payment clauses over the period 1980-2001. For the UK, the 1990 Workplace Industrial Relations Survey reveals that 51 percent of union companies bargained over the size of (non-statutory) severance pay for non-manual workers and 42 percent for manual workers (see Millward, Neil et al, 1992). For Spain-a country usually thought to have high levels of state-mandated employment protection- Lorences et al (1995) document that from 1978-91, the proportion of collective bargaining agreements establishing severance pay in excess of the legislated minimum varied between 8 and 18 percent in the metal manufacturing sector and between 22 and 100 percent in the construction sector.…”

How should job displacement wage losses be insured?

“…Almost all workers are covered in mandated severance programs, but coverage is a problem in voluntary severance plans [6]. In the US, for example, only about one-quarter of the workforce is covered by severance plans, though that quarter disproportionately includes workers with a high risk of being displaced from long-tenured jobs.…”